In “Securing Growth Capital in an Uncertain Marketplace” MarshBerry discussed how growth capital can be a good option in the current volatile macroeconomic environment. Today’s ViewPoint examines why having a detailed business plan is an integral step in raising growth capital and how to avoid common pitfalls in the process.
With an uncertain economic outlook, further interest rate increases possible, and ongoing elevated inflation, having access to capital to both protect vulnerabilities in a business, and capitalize on weaknesses of smaller competitors, could provide an owner with the funds needed to thrive during these uncertain times.
How do you want to grow your firm?
Before you pursue growth capital, you should have a detailed business plan, so you can answer the following questions.
- How much capital do you need to achieve your growth objectives?
- Do you, or any members of your team, want or need liquidity now?
- How much ownership are you willing to sell to achieve these goals?
- At what price would you sell stock?
Some owners are focused on market expansion – extending their footprint to reach new customers. Others want to diversify their product offerings by adding new coverages they do not currently offer. Often, an organization realizes it requires updated technology to improve efficiency or remain competitive. But technology costs money and making needed upgrades with existing capital might not be possible.
The point is, there are many ways that owners can plan to grow – and in our opinion, the key is having that plan before you pursue a capital raising effort.
Beware of other pitfalls. In addition to failing to adequately consider your firm’s growth strategy, there are other common mistakes that can turn a good partnership sour, especially if the owners do not understand the objectives and contractual rights of the capital provider.
Understand a capital provider’s investment horizon. This is how many years the growth capital firm expects to remain an owner in your business – and what the terms are if you do not achieve the growth goals outlined in the partnership documents. For example, does the outside capital provider have the right to an additional ownership stake if certain financial metrics are not achieved? Can a capital provider force you to find a buyer for the company if the capital provider has not achieved liquidity after a certain time period? Can the capital provider force a senior management change if the company loses money?
Watch out for a “creeping tender.” What about when your firm needs more capital because it is performing well? A capital provider may initially agree to invest $25 million into your organization. Two or three years later, you have successfully deployed that capital in acquisitions and organic growth strategies that have met or exceeded your objectives. Along comes another acquisition that could vault your organization into an industry leading role. Your capital provider has the cash and wants to invest at the same price that it initially valued your company. But is this the correct value? After this next investment, the capital provider would own more than 50% of the voting stock and will now be in a control position. This form of “creeping tender” (buying control without paying a control premium) may not be in the best interest of you and your shareholders.
Understand the terms of the deal. It is important that you fully understand the ramifications of specific deal terms that a capital provider is seeking. For instance, what is the economic effect to founding shareholders in a future sale of the business if your growth capital provider buys preferred stock with a liquidation preference? What does it mean for your financial partner to have veto rights over future acquisitions and budgets? Does your minority capital provider have exit rights that, under certain circumstances, provide for a liquidity premium, even though they hold a non-control stake? These and other issues may arise as part of the negotiation process. We believe it would be wise to consider the impact of these shareholder rights before negotiating with a growth capital provider.
In summary, every deal is different. Every negotiation process is different. Avoiding pitfalls such as the ones outlined here speaks to the need to enlist a trusted adviser with experience in helping firms such as yours raise growth capital. Doing so may help you avoid making mistakes that could take away the very thing you so wanted to protect — control.
If you have questions about Today’s ViewPoint or would like to learn more about how market activity may impact your firm, email or call Gerard Vecchio, Managing Director, at 860.916.4149.
Investment banking services offered through MarshBerry Capital, LLC, Member FINRA Member SIPC and an affiliate of Marsh, Berry & Company, LLC. 28601 Chagrin Boulevard, Suite 400, Woodmere, Ohio 44122 (440.354.3230)